Pension Effect From Tax Plan Is Called Slight

The Senate Finance Committee heard testimony on Thursday that pensioners would not suffer from higher taxes for private equity and hedge fund executives.Credit
Brendan Smialowski for The New York Times

WASHINGTON, Sept. 6 — Pension fund and tax specialists told Congress on Thursday that a proposal to more than double the tax rate of executives at private equity and hedge funds, who invest retirement monies, would have negligible impact on the returns received by pensioners.

The testimony was significant because critics of the tax proposals have maintained that fund managers would pass on any increase to investors, thus lowering the returns of pension funds that millions of Americans rely upon for their retirement.

Specialists testifying before House and Senate committees said that although the pension funds had invested billions of dollars in hedge and equity funds, the amounts are a small part of their overall assets — less than 10 percent, according to recent studies. As a result, they said, an increase in the tax rate for the managers of the hedge and equity funds would not significantly harm pension funds.

This year, senior lawmakers in the House and Senate introduced legislation to increase the tax rate of private equity and hedge funds. They are seeking to use the extra revenue to offset spending and reduce taxes in other areas, most notably a reduction in the alternative minimum tax. The legislation has gained traction in the House but faces significant obstacles in the Senate.

A bill in the House introduced by senior Democrats on the Ways and Means Committee would raise the rate on investment gains of fund managers, known as carried interest, to the ordinary income tax rate of as much as 35 percent; the current rate is the capital gains rate of 15 percent.

At a daylong hearing, lawmakers heard conflicting testimony about the legislation and its effect on the economy. Bruce E. Rosenblum, managing director of the Carlyle Group and chairman of an industry lobbying organization, said that increasing the taxes would drive overseas “growth capital now invested to strengthen American companies.”

“There is no inequity in the current taxation of capital gains attributable to carried interest,” Mr. Rosenblum said. “Fairness requires that the tax code not single out certain investors for less favorable treatment.”

But Leo Hindery Jr., a former executive in the cable television industry who is now managing partner at a private equity fund, InterMedia Partners, disagreed, telling the committee that the industry had taken advantage of a “tax loophole the size of a Mack truck.”

“Congress, starting with this committee, needs to tax money management income, what we call carried interest, as what it is, which is plain old ordinary income,” Mr. Hindery said. He called the argument that the tax increases would hurt the economy “self-serving” and “complete poppycock.”

He was joined by William D. Stanfill, a founding partner of TrailHead Ventures, a venture capital firm in Denver, who said that his compensation should be taxed the same as teachers, firefighters and movie stars. “I don’t think it’s fair for those teachers and firefighters to subsidize special tax breaks for me and other venture capitalists,” Mr. Stanfill said. “Or for private equity and hedge fund managers.”

Lawmakers questioned four panels of witnesses on what a higher tax might do to the industry and the economy.

“I believe there would be an adverse economic impact,” said Jack S. Levin, a partner at Kirkland & Ellis who has written extensively on private equity and venture capital.

Most of his panel disagreed. Dispelling the notion that higher taxes would lead to lower returns, Orin S. Kramer, chairman of the New Jersey State Investment Council, said, “In competitive markets, firms cannot automatically pass their costs on to their customers.”

Many members and panelists focused on issues of equity.

“It does not take a Ph.D. in economics to see that the average family pays an average rate of 25 percent while someone making a lot more money is paying 15 percent,” said Darryll K. Jones, a panelist who is a law professor at Stetson University College of Law.

In the Senate, the chairman and the ranking Republican on the Finance Committee have introduced a measure that would raise to 35 percent from 15 percent the tax rate on certain partnerships that go public, like the Blackstone Group and the Fortress Group.

At a hearing before the Finance Committee, Alan J. Auerbach, director of the Robert D. Burch Center for Tax Policy and Public Finance at the University of California, Berkeley, said fallout from an increase would be hard to predict, but he estimated that pensioners might see a decline in returns of 1 basis point, or one hundredth of 1 percent.

An error has occurred. Please try again later.

You are already subscribed to this email.

He said that the proposed increase could lead to higher costs for private equity and hedge funds, which would be shared by investors and fund managers.

Russell Read, the chief investment officer of the California Public Employees’ Retirement System, or Calpers, said he could not predict what a higher tax rate would do to his programs’ returns. He noted that only about 7 percent of Calpers’ assets of more than $240 billion were invested in private equity, although he added that those investments were important because they had consistently outperformed other investments and added billions of dollars in incremental returns.

“It’s hard to tell what the effect would be,” Mr. Read said. “Our hope is that it would be small.”

Senator Max Baucus, the Montana Democrat who heads the Finance Committee, suggested that he did not believe an increase in taxes would significantly affect pensioners because of the competitiveness of the marketplace for investments by pension funds.

“The data says to me that hedge funds and private equity funds may need pension funds more than pension funds need private equity or hedge funds,” Mr. Baucus said. “And that means that hedge funds and private equity funds may not have the economic power simply to pass along increased costs to pension funds.”

Recognizing that no broad-based support had developed in the Senate for the House proposal, Mr. Baucus has not introduced legislation to increase the tax rate on carried interest. His decision to hold a hearing on the subject on Tuesday suggested that he was interested in the idea and might support a measure after the House acts.

Even before Thursday’s hearings, some public pension fund managers had disputed the notion that taxing the income of private equity managers at ordinary rates, rather than the lower capital gains rate, would hurt returns.

“I don’t buy it at all,” said Michael Musuraca, the designated trustee for the $42 billion New York City Employees Retirement System. “I don’t buy that their paying additional taxes will limit their incentives to make money for themselves or their pensioners. I think they have enough incentives to do their business.”

In response to the legislation, the private equity industry has intensified its lobbying.

According to a document prepared for Senator John Kerry, the Massachusetts Democrat, by one equity firm, the Blackstone Group, the taxing of publicly traded partnerships at a higher rate would result in less tax revenue for the federal government.

The document noted that the proposal was “so oppressive that it would in effect deny access to public markets to a vibrant, growing part of the U.S. economy that is a critical force underpinning the health of the whole U.S. financial services industry (already under duress) and the economies of many major cities in the U.S.”

Some specialists, however, question that logic, asking how raising taxes could create less revenue if the industry is such a significant and growing part of the economy.

“One of the funny things about this debate is that according to the industry, it is not going to raise any revenue but at the same time, it’s going to shut down the industry. They can’t both be true,” said Daniel Shaviro, the Wayne Perry professor of taxation at New York University.

“If they are so concerned with the pensioners then they shouldn’t be paying less than the pensioners that they are serving,” Mr. Musuraca said.

A moment of comic relief came when one member of the House Ways and Means Committee pressed some of the panelists who work in the hedge fund industry to estimate the average pay among hedge fund managers.

After an awkward silence, and prodding by the congressman, one witness conceded “millions,” and then $500 million. The top earner last year, according to Institutional Investor’s Alpha magazine, earned $1.7 billion.

A version of this article appears in print on , on Page C1 of the New York edition with the headline: Pension Effect From Tax Plan Is Called Slight. Order Reprints|Today's Paper|Subscribe